Inflation or Deflation

Inflation or Deflation

February 18th, 2009

Just a few months ago, inflation was the spectre that stalked us all. By September, inflation had soared to 5.2%, fuelled by high prices for food and energy. However, following sharp falls in commodity prices and declining demand for goods and services, inflation no longer appears to be a problem and deflation is the new threat. Deflation is defined as a persistent and sustained decline in prices. A sustained deflationary spiral can help to exacerbate recession as, although some people might welcome an environment of falling prices – particularly after a period of high inflation – a sustained period of deflation could have very negative consequences for the struggling UK economy. In a deflationary environment, consumers will delay making purchases, believing that prices for goods and services will continue to fall. This delay makes it harder for companies to sell their products, forcing them to slash prices and leading to lower profits, declining wages and job losses. In turn, the reduction in disposable income further impairs demand for goods and services, creating a sustained and damaging spiral. The Bank of England (BoE) and Chancellor of the Exchequer have taken aggressive actions to try and avert a prolonged period of deflation by cutting rates and introducing a programme of fiscal stimulus. However, even with billions spent and the recent slashing of rates, a risk of below-target inflation still threatens and no one knows how long it will last.  

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